Question

# Question Set 7: Purchasing Power Parity and the Law of One Price The table below contains...

Question Set 7: Purchasing Power Parity and the Law of One Price

The table below contains the price of a Big Mac in different countries in the world in January 2017[1]. You will use the information in the table to explain how Big Macs would be traded between countries if Big Macs could be traded among countries.

Country

Big Mac Price

Actual
Exchange Rate

Actual Price in U.S. Dollars

United States

\$5.10 (U.S.)

1.0 U.S. Dollar
per U.S. Dollar

1.0 U.S. Dollar per U.S. Dollar

\$5.10

Japan

380 Yen

116.7 Yen per U.S. Dollar

Switzerland

6.5 Swiss Francs

1.0

Indonesia

31,000 Rupiahs

13,329 Rupiahs per U.S. Dollar

1.3 Canadian Dollars per U.S. Dollar

China

19.6 Yuan

6.9 Yuan per U.S. Dollar

Mexico

49 Pesos

22.0 Pesos per U.S. Dollar

With the information in the table above, complete and answer the following:

Calculate the purchasing power parity exchange rate between the United States and each of the countries listed above. Remember, purchasing power parity assumes the price of Big Macs in each country would equal \$5.10 U.S. dollars.

Using the actual exchange rate in January 2017, calculate the actual price of the Big Mac in U.S. dollars in each country.

If Big Macs were freely traded among countries, in which country would you purchase Big Macs? To which country would you trade Big Macs? What will happen to the price of Big Macs over time in the world if trade occurred?

Explain whether purchasing power parity holds between countries in the long-run.

What factors explain differences in exchange rates in the long-run?

[1] “The Big Mac Index”, The Economist, January 12, 2017.

 COUNTRY BIG MAC PRICE PURCHASING POWER PARITY EXCHANGE RATE ACTUAL EXCHANGE RATE ACTUAL PRICE IN U.S. DOLLARS UNITED STATES \$5.1 (U.S.) 1.0 U.S. DOLLAR PER U.S. DOLLAR 1 U.S. DOLLAR PER U.S. DOLLAR \$5.10 JAPAN 380 YEN 595.17 YEN 116.7 YEN PER U.S. DOLLAR \$3.26 SWITZERLAND 6.5 SWISS FRANCS 6.5 SWISS FRANCS 1 \$5.10 INDONESIA 31000 RUPIAHS 67467.9 RUPIAHS 13229 RUPIAHS PER U.S. DOLLAR \$2.34 CANADA 6 CANADIAN DOLLARS 6.63 CANADIAN DOLLAR 1.3 CANADIAN DOLLARS PER U.S. DOLLAR \$4.62 CHINA 19.6 YUAN 35.19 YUAN 6.9 YUAN PER U.S. DOLLAR \$2.84 MEXICA 49 PESOS 112.2 PESOS 22.0 PESOS PER U.S. DOLLAR \$2.23 1) If Big Mac would freely trade then I will purchase from China 2) I would trade to U.S and Switzerland 3) I world trade occur then there will be fall in purchasing power of U.S. and Switzerland for Big Mac product

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